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FEDEX SHARES HAVE MORE THAN doubled since closing at 34.28 on March 9, handily outpacing the Standard & Poor's 500 Index, as investors poured into cyclical stocks likely to rebound early in an economic upturn.

The industry's tough dynamics were illustrated when Germany's DHL pulled out of the U.S. domestic package-delivery business in January. But there are stirrings of an economic recovery, as evidenced by FedEx's projection that on Dec. 14, which it expects to be its busiest day in 2009, it will transport more than 13 million packages -- compared with 12 million on 2008's peak day. That's a roughly 8% increase in volume. On average, it ships more than 7.5 million packages daily.

When the economy recovers, "FedEx will be in an even better position than it has been in the past," says Rob Pickels, a senior analyst at asset manager Manning & Napier, which owns FedEx shares. He estimates that the company, which had profit of $3.67 a share for its most recent fiscal year, can earn $7 to $9 in a more normal economy. "Maybe it takes a while for demand to get back to prior levels," Pickels adds, "but FedEx is leaner and will have more market share and more earnings power in the next upcycle." FedEx made $6.67 a share for its fiscal year ended May 2007, before the economy tanked.

Launched in 1971, the company has evolved from a speedy-delivery organization into a multifaceted transportation specialist, having expanded into areas like logistics support. FedEx can bundle a suite of products to customers. Its 65-year-old founder, CEO Frederic Smith, has been in charge for nearly 40 years, and shows no signs of slowing down. "I don't have any plans to go anywhere for the foreseeable future," he says.

FedEx shares have been a good investment over the past 10 years, with a total annual return of 5.7%. That's way ahead of larger rival UPS, whose annual return is minus 0.3%, and the S&P 500, which is at minus 0.9% for the span.

The company's most recent earnings results, which beat expectations, nonetheless illustrate many of its obstacles. An asset-intensive operation, FedEx has budgeted $2.6 billion this fiscal year for capital expenditures, including new aircraft. Its profitability hinges on revenue growth to offset those high fixed costs. For the quarter ended in August, revenue slid to $8 billion, down 20% from a year ago, amid the weak economy and lower fuel surcharges. Net income was 58 cents a share, down from $1.23. Operating margin fell to 3.9%, versus 6.3%.

But FedEx has considerable operating leverage. When revenue does improve, its costs won't grow as quickly, thereby boosting profit. What's more, over the past 18 months, FedEx has slashed costs by about $3 billion; half those cuts are said to be permanent. The reductions have involved, among other things, cuts in base salaries, merit raises and 401(k) matches.

BY FAR THE LARGEST REVENUE producer is FedEx Express, a global-transportation network that reaches more than 220 countries. For fiscal 2009, which ended in May, the Express unit accounted for $22.4 billion, or nearly two-thirds, of total revenue. With its unionized pilots, extensive fleet of aircraft, landing fees and other costs, it is an expensive business to run. Hence its operating margins are typically lower than those of FedEx Ground. However, Express boasts healthy operating leverage, especially internationally. When global trade fully revives, it could get a nice boost.

Meanwhile, FedEx Ground, which covers North America and Puerto Rico, "is a great diversifier to help the company protect its margins during hard times," says Morningstar's Schoonmaker, who puts FedEx stock's fair value at 101. In the most recent quarter, Ground's revenue was down only 2%. One reason for Ground's superior operating margins is that it has significant variable costs, in great part because it uses independent drivers, working under the FedEx brand. These pickup and delivery contractors' weekly compensation is largely based on the number of stops and packages. Last year, the ground unit accounted for about 20% of total company revenue, compared with 11% in 2000.

Also encouraging is that FedEx has increased its share of the U.S. domestic ground-parcel market to 22%, as measured by volume, from 10.6% in 1999, according to the Colography Group, a transportation-consulting firm in Atlanta. UPS's share fell from 75.3% to 67.7% over that stretch. (FedEx also has picked up market share in its Express and Freight operations, Colography says.)

The use of the independent contractors, however, is a concern to some. This arrangement has led to a fierce legal fight between FedEx and the Teamsters union, which represents UPS employees. The dispute hinges on whether independent contractors should be classified as employees, thereby making them eligible to join a union. FedEx maintains that the contractors run their own businesses. In a big victory for FedEx in April, a federal appeals court ruled that FedEx Home Delivery contractors at two Massachusetts locations were properly classified, overturning an earlier ruling by the National Labor Relations Board. If this classification ever is overturned -- and several legal challenges remain -- it would hurt the company's bottom line. However, "it feels like FedEx has been winning more battles than it's been losing in the recent past," says Justin Yagerman, a research analyst at Deutsche Bank who rates Fedex a Buy and has a 12-month price target of 98, or 20% higher than the stock's current level.

One of the recent bright spots for Ground is Smart Post, which specializes in smaller packages delivered from businesses to consumers, with the U.S. Postal Service handling the last leg of delivery. This enterprise dovetails with the growth of e-commerce.

FEDEX FREIGHT IS IN A TOUGH stretch, owing to poor pricing and excess industry capacity. Revenue fell 27%, to $982 million, in the first quarter, and margins shrank. Nevertheless, competitor
YRC WorldwideYRCW 26.308900523560208%YRC Worldwide Inc.U.S.: NasdaqUSD19.3
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(YRCW) has struggled under a huge debt load, while FedEx has a much stronger balance sheet. "FedEx is probably more focused on market share and building up a long-term book of business" in freight, says Yagerman. For now, FedEx has better pricing power in Express and Ground, where it plans to pass along rate increases in January.

While the economy remains FedEx's biggest wild card, there are encouraging signs, among them U.S. gross-domestic-product growth at an annualized 3.5% in the third quarter and a 0.7% increase in U.S. industrial production in September. And FedEx's Ground and Freight segments notched positive month-over-month volume trends during its most recent quarter, while International Priority's shipping volume within the Express unit rose for a second straight quarter.

Even amid the downturn, FedEx has continued to invest heavily in its infrastructure. One area it has focused on: better aircraft and related equipment, on which it's spending $1.2 billion this fiscal year. For example, Boeing 777Fs cut travel times between the U.S. and Asia by one to three hours, compared with FedEx's existing MD-11s, and are much more fuel efficient. By next April, the company plans to have four 777Fs in service, and it plans to add many more over the next decade.

Randall Haase, who runs the Baron Fifth Avenue Growth Fund (BFTHX), which has a FedEx stake, says that the company will capitalize on the growth of global trade, ramped-up e-commerce, and just-in-time inventory restocking. "They are in a great position," he says.

FedEx gets about 25% of revenue overseas, but that will rise, given its strong footprint in China -- it opened its Asia-Pacific hub in Guangzhou -- as well as India, Mexico, Canada and the U.K. Says CEO Smith: "We have a huge opportunity to expand our international business, and we are doing so."

The Bottom Line

Buoyed by its profitable ground unit, growing overseas business and good operating leverage, FedEx looks like a good investment bet. Its shares, at 82, could climb to about 100.

FedEx deserves kudos for its overall strategic plan and vision, but some critics say it overpaid for copy-shop Kinko's, which it acquired in 2004 for $2.4 billion. "Kinko's is an asset-intensive drop box," says Morningstar's Schoonmaker. "And buying a copy shop turned out to be ill-timed, due to increasing use of electronic media and home printing."

FedEx argues that the FedEx Stores, formerly Kinko's, provide an entree to the retail market and generate about $1 billion in annual package revenue that is very profitable because walk-in customers typically pay up for its services. And it has added Web-based capabilities for customers.

In any case, says Baron Fifth Avenue's Haase, "as the economy gets better, their business is going to improve tremendously." In the meantime, FedEx is delivering enough value to keep long-term shareholders happy.